I often refer back to posts I have written over the past 4 years or provide links.   From time-to-time I take a trip down memory lane and reread much of what I have written here.   So to make it easier on myself and maybe provide some enjoyment to anyone that likes to peruse old stuff, I will be flagging posts that I feel are important…for their predictions, for their warnings, for their ability to help investors or just because I found them humorous.   To be fair, if I find something that turned out to be pathetically wrong, I’ll create a special category that is the opposite of this one.

It’s likely that you’ll be hearing about the risk of further dollar declines tomorrow (Monday). Click here. As I have previously written, I am always worried about the end of Petrodollars and unpegging (click here if you care what I wrote on July 15, 2007). The media seems like it is finally waking up to these issues and I suspect you’ll have your fill of confusing commentary from supposed experts on the topic over the next few days. Please ask yourself where these experts were until now. Why did the media not prop them in front of the camera to be responsible journalists trying to help you not lose money? Every time Jim Rogers has been on for months, he has been saying loudly and to anyone that was willing to listen that the dollar and dollar pegs are doomed. He’s gone to the extent of moving out of the United States and trying to sell every dollar-denominated asset in his portfolio. Given the size of his portfolio you might think that people would respect his opinion on things like this, but instead, I’ve heard more than a few chuckles about his doomsday behavior. Kinda like me, but without the money and the profile. But consider people like Peter Schiff of Euro Pacific Capital - every time CNBC or Bloomberg or whomever puts him on, the other guests criticize or laugh at Peter and his alarmist attitude. It’s not about Peter or Jim Rogers and it certainly isn’t about me. Bullish investors, politicians, media et al do not want to discuss this topic because it threatens them. So instead, you get what you get.

Last week, I shared my personal decision to sell out of some money market mutual fund assets. Please read today’s excellent story by Bloomberg about the propping up of money market funds. In my opinion, there are few threats to the debt and equity markets that are more serious than a failure of these assets - a “breaking of the buck” as they call it. In fact, as it relates to the confidence of individual citizens in the banking and investment systems, I doubt anything poses a greater risk. If a lot of people did what I did a few weeks ago, there would be a massive “run on the bank” that would affect multiple asset classes in a way that a traditional deposit crisis would never do. Hopefully that will not happen and as we know, the fund managers would do everything possible to meet any shortfall.

Over and over the bulls chant about “all that money on the sidelines” and for the most part, they are talking about money market assets. So when you read Bloomberg’s piece and realize that the biggest of the big fund managers are stuck with billions in SIV’s and related ABCP - well, it appears that there isn’t as much money on the sidelines as you often hear about. If they would actually be marked-to-market, I wonder how many money market funds are now sitting there with $1.00 NAVs. As I wrote recently, be careful of the consequences of politicians and regulators pressuring for ratings downgrades on these products. My belief is that if the government actually enforced all the securities regulations and if all the fiduciary duties were met, there would be hell to pay. Instead, we suspend the rules, we look the other way…we just hope that things go back to the way they were.

When the Treasury’s M-LEC strategy was revealed, a few of us were concerned that money market fund managers like Federated and Fidelity were included in the discussions. Now, it’s a bit clearer why they were there and it is not comforting. The government and a few large institutions “propping up” money market funds is not a good sign - regardless of how it is spun.

If you were pleased by the assurances that the Fed is aware of the problem and they will do whatever they need to do to deal with it, you’ll probably also benefit from knowing:

• The sun is likely to come up tomorrow.
• The administration is concerned about terrorism.
• The Treasury has a strong dollar policy.
• Objects in the mirror are closer than they appear.
• Hot surfaces may burn.

I have heard way too many market participants suggest that they were confused about whether the Fed knew what they knew.  As if they knew more than the Fed.  So now that Ben has assured you that he in fact is not asleep, what the hell good is that?  He has been busting his ass doing extreme things with monetary policy and he’s accused of being asleep.   I learned nothing from his Jackson Hole commentary and didn’t need him to tell me he was paying attention.  Apparently, investors like this kind of thing.

For the past month, I have been writing that when I weigh the actions of the Fed and other Central Banks against what we know is actually going on in the world economy and financial markets - it just hasn’t added up. I’ve been doing more thinking about this issue and what I must be missing than I have ever done on another topic. As a result, this will be a very long post. Sorry for that.

When it comes to the current intervention, I’ve consulted with experts in international finance and monetary policy and most of them are as perplexed as I am. The actions of the Fed and Central Bankers are so disproportionately extreme that they seem historic to me so I am looking for an historic event. Usually monetary policy follows a series of lagged economic data and reacts to it. This time around, it seems like Central Bankers are getting in front of a liquidity crisis that they fear but has not yet appeared in full force. A few days ago, I included Commercial Paper in a list of problems that I didn’t feel were equivalent to the Fed’s actions. After doing a lot of research and thinking, I believe I was wrong. If I was to bet on one thing that would be worthy of the intervention - it’s Commercial Paper.

Since many investors are not that familiar with Commercial Paper, I’ll just give you a decent link from Fidelity. For simplicity sake, just consider Commercial Paper short-term IOU’s from companies assumed to be of extremely high-quality and low credit risk. About 2000 US companies use CP to fund their short term needs. In good times, investors get access to comparatively high yields with minimal risk and liquidity from maturities that range from overnight to 270 days. In good times, when they come due they are just rolled over to the same investor or there is sufficient demand from new investors. That has stopped in the $1 Trillion Asset-Backed Commercial Paper (ABCP) segment. We are not in the good times right now.

In the risk factors of CP that you’ll find in any prospectus including these assets, there will likely be a mention about how there is minimal risk because of the short maturities. That has been broken. Default risk assumptions have also been trivialized and those have also been broken. Reinvestment risk is hardly ever discussed and that has definitely been broken. Investors have taken a lot for granted in the CP market for many years and that ignorance is costing our markets dearly.

In Europe, the ABCP market has increased about 18 times in the past decade. In the US, the total CP market has grown from $959 Billion in 1997 to about $2 Trillion today and the ABCP has increased about 5-fold. The growth in this area is like subprime and CDOs so it’s not unexpected that controls have gotten “out of control.” And once again, the ratings agencies are at the heart of this issue. Just as they did with the subprime fiasco, you can fully expect that they will be rushing in at this late date to downgrade commercial paper. Unfortunately, the Asset-Backed Commercial Paper has credit concerns because it finances things like credit card and trade receivables, as well as car loans and oh yeah, subprime mortgages. So if you believe the consumer is in trouble and a recession is on the way, it’s probably easy to understand why investors don’t want to touch this stuff.

I strongly recommend that you take a break from this long post and read a very telling article written in 1998 by economists at the St. Louis Fed. Here’s an excerpt from the conclusion:

Since the early 1970s, the commercial paper market has matured considerably. Commercial paper is now one of the more, if not the most, important instruments in the U.S. money market, thanks in large part to rating systems and backup lines of credit. As a result, the market is well-equipped to deal with small- to moderate-sized defaults.

Still, because no Penn Central-sized crisis has occurred in the past 27 years, the market remains essentially untested. Although the insurance that banks provide against “rollover risk” reduces the probability that a severe liquidity crunch could occur, the insurance also, however, transfers the liquidity risk from commercial paper issuers to the banking system. This guarantees that any potential liquidity crisis would be much more severe. It’s this risk of a systemic shockwave that makes it necessary for the Fed to keep an eye on the commercial paper market as it heads toward the $1 trillion mark.

The Fed has been worrying about this problem for decades - ever since Penn Central and Mercury Finance but CP has not been tested for over ten years and never at the $2 Trillion level. They are being tested now and this time, it’s a global problem that is much, much bigger.

According to Fitch, banks worldwide have $891 billion at risk because of credit agreements on asset-backed commercial paper programs. If they cannot roll the CP over, they have to put it on their books as loans and that affects their capital and reserves in dramatic ways. Meanwhile, they have to pay back investors and seize the collateral which puts them in the position of collecting payments they are not set up to deal with.

As companies draw on emergency lines of credit to cover for the shortfall in CP funding, the banks are rapidly taking on much bigger levels of riskier debt than they had anticipated. And don’t forget that banks use CP to raise funds for their own operations so the freezing of the CP market is a double-whammy. At some point, banks might find it difficult to make new loan commitments to fund the rest of the economy until this situation becomes clearer. Right now, banks are hesitant to lend to each other and if they cannot trust other banks where can they turn? This really is a death spiral that ends up with the Lenders of Last Resort - the Central Bankers.

In the US, we’ve largely escaped a systemic problem but individual names have been brought to their knees. More than 20 companies including H&R Block, Countrywide, Luminent Mortgage and Thornburg Mortgage have been unable to roll over asset-backed commercial paper. Meanwhile, Commercial Paper is locking up financial markets around the globe from Canada to Europe to Asia including banks and hedge funds. While big name banks like State Street, Lloyds TSB, Royal Bank of Scotland, and HSBC have billions in ABCP conduits, smaller banks are also at risk.

One of the biggest problems is that as this crisis continues, investors are less willing to take the same risk for longer periods. They fear that a 90-day commercial paper commitment might not hold up for that long so they are shortening the maturity to one month. One month notes become weeklies where you have to deal with the reinvestment risk 4 times in the same 30-day period. Similarly, weekly notes are becoming overnights - in fact, some estimates have about 25% of the European ABCP market being financed with overnights. This process is pushing up yields to levels not seen in the past seven years and it’s creating a backlog of ABCP that is forcing the banks to put the loans on their books. Meanwhile, the former CP investors who are getting paid off by the banks are investing the cash in Treasury Securities which explains the persistent declines in the T-bill yields.

Until now, almost everything I’ve talked about is related to banks and corporations but it’s important to remember that if the Commercial Paper market stays locked up, consumers will find it difficult to get capital to make purchases that fuel the economy. More importantly, I am increasingly concerned about individuals and their perception of safety in what they consider to be “cash” deposits. Commercial Paper affects retail depositors because it is a significant holding of most money market mutual funds. If there ever was a threat to Breaking the Buck, Commercial Paper is it.

The longer this situation persists, the worse it gets. You can keep track of the Commercial Paper market by clicking on this link to information compiled by the Fed. If you read the major financial media stories on the drawdown of CP on Thursday, you might assume that things are getting better as the amount of ABCP declines. But just remember that the money is coming from somewhere to reduce those balances and that somewhere is the banks. I don’t feel like it’s just going to get better on its own and this looks like a much bigger problem than subprime. When you consider the subprime losses, bridge equity loans and now the commercial paper loans sitting on bank balance sheets, it’s hard to be optimistic about the earnings in the financial sector.

So I am looking at all the Fed intervention to date and when I make the assumption that they have been trying to free up the CP market, it makes a lot more sense. First they tried to encourage banks to lend to each other, then they tried to get banks to borrow from the discount window and extended the maturity dates to prevent the compounding of the ABCP maturity compression, and then they allowed the banks to offer ABCP as collateral for discount window borrowings. Unfortunately, as that ABCP comes due I don’t see how the Fed can keep it as acceptable collateral. At some point, there is a day of reckoning and it is fast approaching.

A week has gone by since the staged show of support for the Fed at the discount window by the four biggies. Back then, I called the real borrowings during the preceding week “Substantially Zero.” Last week, if you subtracted out what we knew about who borrowed the $2 billion and believed them when they said they did not need the money other than to show support for the Fed - you got substantially zero borrowings from the troubled banks that are supposedly requiring all this intervention. So when the new H.4.1 report came out this afternoon, I was very interested to see how much borrowing went on during the past week.

The way I look at the numbers, this week was “Less Than Zero.” The ending balance of Primary Credit as of this Wednesday was $1.101 billion, down from $2 billion last week. Furthermore, the previous balance of $85 million in Secondary Credit was drawn down to $0. The net result was a repayment of about $1 billion at the discount window compared to last week. If you read the major financial media’s stories on this week’s report, you’ll see headlines that tell you the average borrowing increased to $1.315 billion compared to last week’s figure of $1.2 billion. Of course this is a pretty odd way of looking at things. It almost makes you believe that banks are borrowing from the discount window. Sorry, but I just don’t see it that way.

Just do some math on a simple average of seven daily balances. We know the first day was $2 billion (last week’s close) and we know the ending balance was $1.101 billion. Make some assumptions that the biggies repaid $1 billion of the $2 billion during day 3 and kept the other $1 billion as a wonderfully patriotic and continuing sham show of support for the Fed and you can easily create an average around the $1.315 billion reported on the H.4.1.

So in the two weeks after the Fed intervention what do we know? We know that the well-timed announcement screwed the shorts in the stock market and provided a nice bailout rally for the longs. We know that it made Chairman Bernanke and the Fed look very creative, innovative, brilliant (insert other nice adjectives here). But did it result in any actual borrowings by the banks? The way I look at it - IT DID NOT. Things like this really contribute to the claim that the intervention has done a lot to bail out equity markets and not much for the banking system.

How convenient that Senator Schumer (D-NY) decided to publicly share his comforting letter from Chairman Bernanke today. The market really needed a boost after yesterday’s decline and thankfully, one was made available!! Last week it was Senator Dodd and the photo op. This week, it’s a Dear Chuck letter. What’s next? I am glad that Chairman Bernanke is communicating with Sen. Schumer but would prefer that the correspondence be kept confidential. Once again, I have no problem with the Fed doing what they feel they must. My issue is more with the fear that the Fed is doing what others feel they must. Whether that means politicians or investors. Having press conferences to discuss private meetings and letters so they affect the markets is sickening to me. Maybe it calms some people, but not me. The Fed is increasingly being used / abused and the more this happens, the more I start to wonder whether they are innocent bystanders or willing accomplices.

American protectionists blocked the Dubai Ports deal because of “National Security” concerns.   They also blocked the sale of Unocal to CNOOC on similar grounds.  So please remember that as you read this article about China’s retaliation in the form of legislation which will require that acquisitions in their country pass the “national security” test.  Turnabout is fair play as they say.  I know who started it, but where does it stop?  It’s likely that US Congressional “leaders” will end up using this as a further justification for their pressure on the Yuan and an opening of Chinese markets to US products.  And that’s the point - when protectionism begins there is retaliation.  It happened with the onset of Smoot-Hawley and it’s happening again.  If we don’t watch out, the results will be the same.

Of course Chairman Bernanke is watching the markets. But what I really want to know is whether he is watching investors and pundits and “financial journalists” watching the markets. Because if he would do that and torture himself with CNBC for just one whole day he might learn more about “Moral Hazard” than he could ever do studying economic history books.

Here’s what he might notice:

1) On an up day, he is considered brilliant. No further action required. Last Friday, we had numerous permabulls trying to spin the growth in new home sales and durable goods as positive catalysts for markets. Of course, that was because the market went up. You see Ben, when stocks go up, the economic data is encouraging.

2) On a down day like today, all the economic data is viewed as being a sign of a certain recession. Nevermind that the data should have been a surprise to no one. If stocks had gone up today, I am convinced that the “stockonomists” would have been writing them off as meaningless or irrelevantly old. You see Ben, when stocks go down, the economic data is discouraging and sadly, you are no longer brilliant. When stocks decline - the Fed is asleep and negligent. Your failure to cut the Fed Funds Rate is destined to cause economic disaster.

So Ben, just try to get your hands on some video tape of the past few days of CNBC. Just zoom past all the annoyingly repetitive commercials so you can listen to the annoyingly repetitive commentary. You will hear that investors expect you to fix this mess. And if you do nothing, you will be blamed by the Cramers and Kudlows and their ilk.  You may not and should not care.  But sadly, your interventions have been so amazingly coincident to market declines that every time stocks take a dive, investors and commentators expect a new action.  And so far, they have gotten what they wanted whether you intended it or not. So if you dare to do something tomorrow or the next day, it will be rewarded - stocks will go up and once again, you will be a savior. At least until stocks sell the next time…which of course will be met with another round of crying for intervention. It’s never enough for investors, especially since they have turned this into a giant marketplace experiment of Pavlov’s dog theory.

So Ben, please take some time out of your busy schedule and watch the people watching the market.

The one thing that makes the HEDGEfolios Timing Indicator different than most of the market breadth indicators is the element of time that I have programmed into the formula. This week, despite giving 90 new DOWN signals versus 80 new UPs, the passage of time moved me extremely close to bullish territory - a bias that my personal view does not share. I’ve been in this situation several times during the three years since I built the indicator and I’ve learned to trust what it tells me. However, I want to make it clear that until more than 50% of the stocks I cover have UP signals, there is no confirmation of a bullish market reading. At least not in my world.

Historically, a confirmed change in the HEDGEfolios Timing Indicator precedes a move in the market from weeks to months. The last time was April 30th and it took about 10 weeks to finally show up with a decline in the market. I was also wrong from mid-December 2006 until the end of February and it got pretty painful during January. The main lesson for me (other than getting good at being wrong!) is that I just have to trust what the data is telling me regardless of what the famous indices are doing. As I have repeated here and whenever I am asked anywhere else - it is important to buy and sell individual stocks based upon the stock and not the market. I never advocate making wholesale changes to portfolios based upon an indicator or change in the index. However, the market bias should change your willingness to enter or exit positions.

For example, since the end of April I gave DOWN signals on any sign of meaningful weakness in individual stocks and when the decline finally appeared to the market, most of my positioning was already done. However, now as the HEDGEfolios indicators moves toward bullish territory, I am more willing to give a strengthening stock the benefit of the doubt and change the signal to UP. In the past 4 weeks, I have been giving more new UPs than DOWNs. Inevitably, I am early on a bunch of these and I don’t doubt that it may take some time before this decline has bottomed. Based upon past experience, it could be weeks or months. I don’t believe a bottom found us last week but I am certainly becoming less bearish thanks to the 4th dimension.